‘Moral hazard’ key to state, municipal pension bankruptcy

Friday, October 29th, 2010

By Frank Keegan – New Jersey case shows taxpayers can’t put blind trust in any party to get us out of the trillions of dollars in false retirement promises politicians made to public workers. Only intense public scrutiny and demand for immediate radical reform can stave off bankruptcy and social disruption.

Actuaries call it “moral hazard.” Actuaries do?

Why are the most extreme and precise number-crunchers setting their spreadsheets aside to talk about morality in public finance?

Because it is the one factor that makes all other calculation irrelevant.

A general example of moral hazard is politicians and public employees boosting “their outcomes, possibly at the expense of other principals. [and] … elected officials deferring contributions (and the accompanying tax increase) until post-election. … in ways to maximize their own benefits, at the expense of other principals, without appropriate risk disclosures and actionable checks and balances.”

Want a real example? Take a look at New Jersey where Republican Gov. Chris Christie touts himself and Lt. Gov. Kim Guadagno as tough reformers in a state with the highest taxes and 4th highest “economic debt” per capita, according to calculations released this week by investment firm Loop Capital.

How well do these tough conservative Republican reformers score on the actuarial moral hazard test?

They fail — big time. First, Christie committed the worst actuarial crime by continuing to blow off the state’s Annual Required Contribution to the pension funds just as Democrats had for the previous three years.

The state owed the funds at least $3 billion, even if you accept the false assumption of investments earning 8.25 percent a year forever, extended “smoothing” of losses and rigged amortization.

He simply did not pay the bill. Next year it will be more than $6 billion, about 20 percent of the state’s budget. Remove accounting tricks and the debt is much higher. But because of the tricks, nobody knows how high.

And as usual in government, tough reform is for everybody but the ruling party’s cronies.

New Jersey Watchdog reporter Mark Lagerkvist reported last week that as Monmouth County Sheriff, Guadagno made false statements in 2008 to get a police official $170,000 in illegal public retirement pay while he was drawing an annual government salary of $87,500.

That is the other moral hazard common to virtually all states and municipalities compounding this government pension crisis.

The cost of pumped up retirement benefits promised by politicians who ducked out on the bill for others to pay after they left office is going to force drastic service cuts and huge tax increases.

No reforms imposed now will have any impact on the debt, estimated to be at least $1 trillion as of 2007, and probably a lot more than $4 trillion adding in municipalities and accurate estimates of what unfunded retiree health benefits are going to cost.

According to the actuaries, this could “result in tremendous costing increases that would likely be unacceptable to the taxpayers, yet required in order to support constitutionally guaranteed benefits. The current valuation/reporting paradigm does not provide a mechanism for addressing this problem.”

They suggest we shift the paradigm, and we shift it fast.

“These conditions can lead to risk transfers against the long-term health of the system, including biased funding approaches and benefits that allow participants to select against the system. Finally, private sector workers have seen benefits greatly diminished in the last 20 years; will private sector workers (as taxpayers) continue to be willing to fund benefits for public sector workers that are more generous and more secure than the benefits they enjoy?”

We know the answer to that question: NO!

Politicians who betrayed taxpayers and the 27 million active and retired public employees covered by the plans are running out of time. These debts accrue and compound.

Every year politicians fail to act, “the potential grows for a rift in understanding between government employees and the citizens they serve,” according to the actuaries.

To keep that rift from turning into open revolt, governors, legislators, mayors and council members must immediately stop lying to taxpayers and public employees, and start reforming systems falling into a fiscal abyss.

Most of all they must finally listen to their actuaries, especially when those ultimate experts on numbers also warn them against moral hazards.

[…] State and local politicians did not, and they are proving now they never will. The defined benefit pension system is fundamentally, systemically flawed and prey to what actuaries call “moral hazard.” […]

[…] State and local politicians did not, and they are proving now they never will. The defined benefit pension system is fundamentally, systemically flawed and prey to what actuaries call “moral hazard.” […]